A medical marijuana customer counts out cash for a transaction at Native Roots in unincorporated Boulder County in this 2016 file photo.

IRS trawling state-run pot database to block Colorado marijuana companies from claiming tax deductions

Federal tax agents are trawling a Colorado database designed to track pot from seed to sale as a way of proving licensed marijuana businesses are illegally trafficking in the drug.

The tactic is the latest in the Internal Revenue Service’s efforts at ensuring the otherwise-legitimate businesses cannot claim federal tax deductions, the companies say. The tax code prevents businesses that traffic in illegal drugs from claiming deductions.

At least six businesses, most recently the owners of Rifle Remedies, a medical marijuana business in Silt, have separately filed petitions in U.S. District Court to quash IRS summonses for state records that show how much pot the companies have grown and sold over a number of years.

The businesses say the IRS isĀ essentially conducting a criminal investigation that has nothing to do with taxes, an overreach of its authority.

The state’s Marijuana Enforcement Division uses a tracking system known as METRC to monitor the growth and movement of pot statewide. Each plant has a specific code attached to it and every batch of product is traced to the point of sale.

Rifle Remedies’ lawsuit is the latest in a string of cases filed by Greenwood Village attorneys James Thorburn and Richard Walker challenging the IRS rule barring marijuana businesses from claiming any tax deductions. The lawyers have filed more than a half-dozen cases, none of them yet successful though most are pending.

The latest cases involve IRS subpoenas while the earlier ones squared off with the IRS’s own determination that the marijuana business was trafficking in illegal drugs. All of them seem to have similar facts or circumstances.

Neither the lawyers nor their clients returned Denver Post requests for comment. The IRS and MED do not comment on pending litigation.

In court papers, the IRS said it is using MED records only to verify business’ financial records and determine whether they substantiate or undermine information from tax returns.

The IRS began auditing Rifle Remedies in January 2017, “what became clear early on was that what was being conducted was not any form of recognizable civil audit,” according to the company’s motion. “The auditor … has made clear that the purpose of this audit is to determine whether Rifle Remedies is trafficking in a controlled substance … in an attempt to take away all of (its) otherwise lawful tax deductions.”

When the company refused to turn over its METRC records, the IRS subpoenaed the state directly.

Because marijuana remains illegal under federal law, medical and recreational pot businesses are precluded from claiming otherwise-legitimate tax deductions, and the IRS has been auditing handfuls of them to ensure compliance.

To do that, the IRS must first show the business is actually violating the federal Controlled Substances Act by trafficking in an illegal drug, andĀ marijuana remains on that list.

Until now, the IRS has relied on pot businesses – growers, distributors and manufacturers – to concede they are selling the drug, which lawyers say is tantamount to admitting to a federal crime. Once done, the IRS uses section 280E of the Revenue Code in denying any business tax deductions, a move that raises the business’s tax bill by multiples.

Section 280E has typically been invoked on people convicted of drug trafficking, but with the legalization of medical marijuana in 29 states and recreational sales in eight of them, prosecutions have waned. That’s especially true since the U.S. Justice Department has said it would not prosecute legitimate marijuana businesses as long as they comply with state laws.

Story continues below video

The former owners of one marijuana business, Total Health Concepts, have been among those fighting back, saying they’re entitled to claim a Fifth Amendment right against self-incrimination, leaving the IRS to find another way to prove the trafficking.

That case is ongoing and many in the industry have seen it as potentially ground-breaking if THC’s former owners – Kellie McDonald and Neil and Andrea Feinberg – can win.

“The IRS wants a situation where on the one hand, a person will not be prosecuted for violating the CSA when selling state-legal marijuana, but, on the other hand, will have their business deductions denied … for violating the same law for which the taxpayer will not be prosecuted,” RR’s motion says. “This is an Alice in Wonderland approach …”

The cases are in lieu of the Small Business Tax Equity Act, a bill introduced in the U.S. Senate in March that would allow legitimate pot businesses to take the same deductions any other business can take. A similar bill was introduced in the House.

This story was first published on DenverPost.com